Why Changes in Interest Rates Might Not Trickle Down to Your Savings or Chequing Account

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So far in 2017, the Bank of Canada (BoC) has raised its benchmark interest rate twice. After each of those rate hikes, you probably got a letter from your bank to let you know the interest rate on your variable-rate mortgage, line of credit, and maybe even your credit card would also be increasing.

But chances are you didn’t see the good news that you’d also be paid a higher rate of interest on your savings account. And unfortunately, you’re probably not going to. The banks simply don’t have the same motivation to raise rates on their savings accounts, and it all comes down to how they use the money you deposit.

When the BoC changes its benchmark interest rate (known as the overnight rate), the banks usually respond by raising or lowering their prime rate by the same amount. The overnight rate directly affects how much it costs the banks to lend money to you. When the overnight rate is higher, it costs them more and they pass on the expense by raising the interest rate on the loans they’ve given you. When the overnight rate goes down, the banks need to lower rates to stay competitive with their peers. This affects all variable-rate loans, including mortgages, lines of credit, and sometimes credit cards.

But when you deposit money with a bank in a savings account, the economics are different. Canadian financial institutions are subject to capital requirements when they lend out money. In plain English, this means that for every dollar banks lends out, they need to keep a certain amount of cash on hand. They satisfy this requirement in part by taking deposits in the forms of savings accounts and GICs.

Banks also use deposited money to directly fund loans and to invest in other vehicles. Basically, the bank can use your money however it wants until you ask for it back.

Because the banks are using the deposits in your savings account to make money, their incentive is actually to keep savings rates low. Think about it: The less it costs them to borrow money from you, the higher their margins are. If they can borrow money from you at 1%, and invest it at 3%, they only stand to lose out on profits by paying you more interest. The only reason for them to raise their savings account rates is to compete with other banks for market share.

Although competing for your savings is a good reason to raise savings account rates, many banks don’t need to do this. The Big Five banks, for example, have so thoroughly dominated the market that they win your business on brand recognition alone. Many Canadians buy into the false notion that you need to do all your banking with the same financial institution where you hold your chequing account. Others opened a savings account when they were a child and never thought about switching to another bank.

Whatever the reason, the Big Five banks have some of the worst savings rates in the market. At the time of writing, the best savings account interest rate in Canada is 2.3%, offered by EQ Bank. One of CIBC’s savings account offerings, the CIBC Bonus Savings Account, currently pays just 0.05%. If you have a CIBC Bonus Savings Account, you could literally earn 46 times as much interest by switching accounts!

Since the rates are what they are, switching to a new savings account is probably the way to do it If you’re looking for a way to grow your savings faster. Many smaller banks and credit unions in Canada offer very competitive rates compared to the big guys. Just watch out for teaser rates that pay an artificially high interest rate for the first few months and drop within a few months.

You’re unlikely to see any positive effects of rising interest rates when it comes to chequing accounts either. The money deposited in chequing accounts is of little value to the banks because money comes in and goes out so quickly. Banks make money on chequing accounts just by charging service fees and using them as a way to upsell to customers. Very few chequing accounts pay any interest at all.

Since you’re unlikely to earn any interest on the money in your chequing account, the best way to come out ahead is to find the account with the lowest monthly cost to you. Some banks offer no-fee banking options. There are also tools available you can use to compare chequing accounts online. Switching can save you hundreds of dollars a year and it’s often easier than you think.

Rising interest rates are going to have a direct effect on your loans and lines of credit, but not always your savings accounts. But that doesn’t mean you have to be stuck earning little or no interest on your savings. By periodically comparing accounts to make sure you have the banking products that pay the most interest (or charge the fewest fees), you can get the best deal for yourself and show the banks the best way to earn your business is by being competitive.